The Federal Circuit Raises the Bar on Forcing Automobile Manufacturers and Distributors to Defend a Patent Lawsuit in an Inconvenient Location

Complainants often rely on agency law to force a car manufacturer or distributor to defend a patent lawsuit in a federal court located in a district of the complainant’s choice when the car manufacturer or distributor does not have any offices present in that forum but does have a dealership there.  In a recent decision consolidating the In Re: Volkswagen Group Of America, Inc., and In Re: Hyundai Motor America cases, the Federal Circuit Court provided guidance for an arguably narrow interpretation of agency law.

In this case, StratosAudio, Inc., (“Stratos”), filed suit in the Western District of Texas, Waco Division (“Texas”), alleging that Volkswagen Group of America, Inc., (“Volkswagen”) and Hyundai Motor America (“Hyundai”) infringed a patent owned by Stratos. Volkswagen is a distributor of cars that is incorporated in New Jersey. Hyundai is a distributor of cars that is incorporated in California. Neither has an office or other significant presence in Texas. Therefore, Stratos relied on the presence of a Volkswagen dealer and a Hyundai dealer in Texas as a basis for suing both distributors there (likely for convenience purposes). That is, Stratos alleged that the dealers were agents of Volkswagen and Hyundai in order for venue to be proper in Texas.

Stratos made two arguments in seeking to establish the agency relationship. First, Stratos argued that the dealers are agents of Volkswagen and Hyundai simply due to the existence of the franchise agreements that enable them to sell and service Volkswagen and Hyundai cars in Texas. Then, in a more substantial argument, Stratos argued that even if the existence of the franchise agreements in and of themselves was not sufficient to create the agency relationship, the stringent rules and regulations laid out by Volkswagen and Hyundai in the franchise agreements impact the dealers’ day-to-day business to a significant degree that would be sufficient for finding that the two dealers are indeed agents of their respective distributors.

For the second argument, Stratos obtained copies of the franchise agreements between the Volkswagen and Hyundai dealers and their respective distributors. In these agreements, Stratos pointed out that both dealers were required to: (1) employ certain types of employees, for example, a general manager, sales and service staff; (2) maintain a minimum amount of inventory; (3) perform warranty work on consumer vehicles; (4) use specified tools when performing warranty and maintenance work; (5) use distributor-approved computer hardware and software; (6) comply with the distributors’ standards regarding dealership appearance and use of signs and brand logos; (7) comply with the distributors’ working capital requirements; and (8) attend mandatory training sessions (Hyundai) or require staff to have certain training certifications (Volkswagen).

The Texas trial court was persuaded by Stratos’ arguments. . Therefore, the court opined that the two dealers were respectively agents of Volkswagen and Hyundai. This enabled the lawsuit to be heard in Texas. Volkswagen and Hyundai disagreed, and petitioned the Federal Circuit Court to dismiss or transfer their disputes out of Texas by alleging that the two dealers in question are not in fact their agents.

In reviewing the petitions, the Federal Circuit first pointed out that different federal district courts disagree with one another on whether a car dealer should be considered an agent of its car manufacturer or distributor. Therefore, the Federal Circuit sought to provide a uniform and detailed set of guidelines for lower courts to follow in similar future disputes by analyzing agency law as it applies to the Volkswagen and Hyundai lawsuits.

In doing so, the Federal Circuit quickly knocked down Stratos’ first argument by holding that the mere existence of a franchise relationship does not necessarily trigger a master-servant relationship. According to the appellate court, what matters is the nature and extent of the control as defined in the franchise agreement or by the actual practice of the parties.

The court then turned to Stratos’ second argument and agreed that the requirements set forth above for the dealers to follow do indeed provide Volkswagen and Hyundai with some degree of control over their dealers’ business conduct. However, the court disagreed that this level of control was sufficient to establish an agency relationship. According to the Federal Circuit, the eight requirements specifically disclosed above – as well as others not mentioned here – failed to give Volkswagen and Hyundai “interim control”, that is, sufficient control over a certain period of time over their dealers’ process of selling cars and performing warranty work on them.

For example, the Federal Circuit opined that the constraints placed on the dealers via the franchise agreements concerning sales (i.e., minimum inventory, sales staff, displaying the parent company’s logo, providing sales reports, etc.), did not evidence any control over the sales process itself. In addition, the court held that Stratos failed to cite any evidence that Volkswagen or Hyundai maintain influence over the sales process once they have sold a car to a dealership. The court noted that when cars leave Volkswagen and Hyundai’s possession, the distributors retain no authority over the manner in or the price which the cars will eventually be sold to the public. Therefore, the court opined that the dealers’ day-to-day operations, and particularly sales, were under the full control of the dealers themselves, not the distributors’.

Therefore, the Federal Circuit held that the Volkswagen and Hyundai dealers are not agents of their respective distributors. For this reason, venue in Texas is improper, and Stratos is now forced to pursue its disputes in other judicial districts where Volkswagen and Hyundai can be found. Whether Stratos will actually do so remains a pending question.

Importantly, based on the above it appears likely that federal trial courts faced with the same issue will now focus the bulk of their analysis on determining the impact that a manufacturer or distributor’s constraints have on a dealer’s process of selling cars to the public and performing warranty work once that the cars are in the dealer’s possession.